KKR Real Estate Finance Trust Inc.

Good morning and welcome to the KKR Real Estate Finance Trust, Inc. Second Quarter 2020 Financial Results Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Michael Shapiro. Please go ahead.

Thank you, Operator. Welcome to the KKR Real Estate Finance Trust earnings call for the second quarter of 2020. We hope that all of you and your families are continuing to stay safe and healthy. Today, I am joined on the phone by our CEO, Matt Salem, our President and COO, Patrick Mattson, and our CFO, Mustafa Nagadi. I would like to remind everyone that we will refer to certain non-GAAP financial measures on the call, which are reconciled to GAAP figures in our earnings release and in the supplementary presentation, both of which are available on the investor relations portion of our website. This call will also contain certain forward-looking statements which do not guarantee future events or performance. Please refer to our most recently filed 10-K precautionary factors related to these statements. Before I turn the call over to Matt, I will provide a brief recap of our results. As a reminder, we provided a preliminary set of results on Form 8K on July 13th. For the second quarter 2020, we had a GAAP net income of $28.6 million or $0.52 per share, which included a $1.4 million or $0.02 per share benefit from a lower CECL provision. Core earnings were $25 million, or $0.45 per share, the high end of our preliminary estimated range. Core earnings included a $4.7 million, or $0.08 per share, write-off on our small $5.5 million mezzanine loan. Book value per share as of June 30, 2020, increased to $18.57. which included the impact of $1.16 per share from CECL as compared to 1845 as of March 31st. Finally, I would note that in mid-July, we paid a cash dividend of 43 cents per share with respect to the second quarter. With that, I would now like to turn the call over to Matt.

Thank you, Michael. Good morning, and thank you for joining us today. We hope you are all healthy and safe. We are now five months into the pandemic and the company is continuing to show its strength. Our conservative posture over the last few years for both our lending strategy and liability management has differentiated us during this volatile time while still generating earnings power from our LIBOR floors. KRF has a best in class investment portfolio. that was purpose-built for the latter stages of an economic cycle. Our 5.3 billion almost exclusive senior loan portfolio focuses on institutional real estate and sponsorship and is secured predominantly by Class A, lighter transitional, multifamily, and office properties located in the most liquid real estate markets. Today, Our average loan size is 134 million and approximately 80% of our loans are located in the top 10 markets in the US. Our investment portfolio is 99% first mortgage, senior loans with no direct holdings of securities. Our two largest property type exposures are multifamily and office, which represent 81% of the portfolio. In addition, 87% of our multifamily loans and 75% of our office loans are secured by Class A properties. Importantly, more volatile property types like hotel and retail represent only 8% of the portfolio. And as I mentioned, we believe our focus on light transitional properties provides a safer, shorter duration loan. Our future funding as a percent of our total commitment, so effectively how much more value add dollars are going into a property, is currently 9%, which is among the lowest in the industry. We match our loan portfolio with one of the most conservative and diverse set of liabilities. Our team, with the invaluable assistance of KKR Capital Markets has been focused on growing and diversifying our non-mark-to-market financing capacity. As of quarter end, 73% of our liabilities across eight different financing facilities were completely non-mark-to-market, meaning both capital markets and credit marks. This is an important distinction that historically the market did not focus on closely. Patrick will discuss this further in his remarks. Finally, the company benefits from its affiliation and integration with KKR. As a reminder, KKR is KRF's largest shareholder. In addition, our integration with KKR's growing real estate platform allows us to see around the corner to identify investable and non-investable trends. First, KKR Real Estate has one leadership team, and we are fully integrated across our real estate equity and debt businesses. Our extensive portfolio across real estate equity and credit gives us a differentiated view of real estate fundamentals, trends, and values across a broad range of markets and business plans. In addition, we benefit from a one firm culture that rewards information sharing. The one team approach has also led KKR to use all of its relationships and wallet share to encourage our financing relationships to support our growing real estate business and KRES specifically. Our ability to access all of the KKR brain is really driven by that culture of collaboration. Since our last quarterly call, our weekly pipeline discussions have reverted back to market opportunity and originations. With many lenders on the sidelines, we are seeing favorable market dynamics with spreads on light transitional loans increasing by approximately 200 basis points. We recently launched a term loan B, will allow us to take advantage of the market opportunity we see today. With a focus on the same high-quality real estate we have been underwriting since our IPO. While we will be measured and selective in new investment opportunities, we are actively quoting transactions and believe we are well-positioned to take advantage of the attractive lending environment. As we had indicated in our pre-release last month, 99.8% of our borrowers made their interest payments in the second quarter and July. Through our robust quarterly asset review process, we reevaluate every loan in the portfolio to sign an updated risk rating. Our portfolio, which totaled 5.3 billion at the end of the quarter, has a weighted average risk rating of 3.1 on a five point scale. One small mezzanine loan that was substantially written off moved from a four rating to a five and one loan moved from a three rating to a four rating given a recent change in the sponsor's underlying business plan. 84% of the portfolio was risk rated three or better and we feel good about the performance on those properties. To date, only two loans, our two hospitality loans, which we discussed in detail during our last quarterly call, have had any payment-related modifications. In an effort to continue to increase the level of transparency for our investors, we provided a detailed breakout of our four rated loans this quarter on page 14 of our supplemental. As a reminder, We had no four or five rated loans prior to COVID. The 16% in this category are predominantly secured by more COVID sensitive property types like hospitality, retail, and for sale condo housing. We feel very good about our relative position in many of these properties and are seeing improving trends in a number of the business plans. Our Portland retail property is most negatively exposed, and we maintain frequent dialogue with the sponsor given the property's planned sale, near-term loan maturity, and the underlying business plan, which incorporates both retail and entertainment providers such as Live Nation. Given the limited portfolio activity in the second quarter, I thought I would spend some time diving deeper into our multifamily and office portfolios this quarter. While we believe our overweight positions and these property types is a differentiator, it is also important to understand our level of conservatism within the asset class, especially in today's environment. So let me spend a few minutes providing some incremental background. On page 10 of our earnings supplemental, we provided some disclosure for our multifamily and office portfolios. Starting on the multifamily side, our average loan size and weighted average LTV was 146 million and 67% respectively. Notably, less than 1% of our multifamily portfolio were for construction, and the weighted average occupancy was 74%. Let me spend a minute highlighting the typical fact pattern that we would lend on in the multifamily segment. Typically, we provide construction takeout financing, giving our sponsors a better cost of capital and time to lease the property and burn off the initial lease up concessions. Having just been built, the properties are Class A, with many having the best amenities in the market. We like lending on this fact pattern because we usually have a number of leases in place The property is already built, and there are no moving pieces as it relates to construction. We can look at the individual leases that have been signed and extrapolate that into a stabilized cash flow, which we think creates a straightforward underwriting and a simple business plan. Underlying collection on our multifamily properties continue to show a strong trend in the 90% area. On the office side, we have a similar average deal size, but a lower weighted average LTV at 64%. We have no exposure to some of the larger co-working tenant markets like New York, San Francisco, or Los Angeles, and less than 1% of our space is occupied by co-working tenants. We typically lend on lighter transitional or value-add projects, and we value in-place tenancy and cash flow for the stability it provides. Our going in average occupancy on our office portfolio was 72%. So there's no heroic underwriting assumptions for lease up. We will provide capital for renovations to upgrade things like the lobby, elevator cabs, or add amenities to the building. Our underlying office occupancy remains in the high 70s with a weighted average remaining lease term of over six years and a weighted average debt service coverage ratio in excess of 1.4 times. Our underlying collections have shown relative stability and are only slightly lower than our multifamily portfolio. We believe these overweights represent our differentiated investment strategy. and conservative portfolio, which will continue to position KREF well in the current environment. Now let me turn the call over to Patrick.